Rationalizing Clearfield's 50 P/E Requires Factual Errors And Implausible Assumptions

Includes: CLFD
by: Brendan Rose


Clearfield's worth $8 at the industry norm P/E.

Clearfield's trailing 12 month earnings yield is 2%.

Of the three recent CLFD bull pieces on Seeking Alpha, one doesn't value the company, one makes an enormous factual error, and the other relies on insane growth projections.

"All intelligent investing is value investing - acquiring more than you are paying for. You must value the business in order to value the stock."

Charlie Munger

The investors slamming "market buy" Clearfield (NASDAQ:CLFD) orders aren't following Munger's advice. Let me show you by describing three recent bullish CLFD writeups. (For more background on CLFD, see my original report.)

Ultra conservative Tom Shaughnessy thinks CLFD is worth $39.81. How'd he get there? By:

"Aiming for an ultra conservative viewpoint of a high growth company, I have chosen to use a 50% growth figure for the first five years that is not unbeknownst to the company or its share price. Using a discount rate of 10% since it is a high growth industry and a 20% margin of safety to boost the conservative nature of the calculation brings us to a share price of $39.81 or 92.60% higher than current levels. I consider this DCF method conservative in nature, in covering my bases for a high growth company in a fast paced industry."

As a general rule of thumb, extrapolating growth achieved in a record year off into the distant future is - what's the polite way of saying this - not "ultra conservative". Record years are records because they're unusual.

I recommend Celan Bryant's piece on Clearfield for its clarity and depth. But her bullish conclusion is based on an enormous factual error. She thinks the Telco Equipment sector P/E is 40-50. But the table she uses also claims the aggregate market's P/E is 52! (NASDAQ 1999, baby!) Obviously both multiples are bonkers. Actually, the same data table includes a market weighted valuation column showing that 16 is the P/E of the aggregate market and the Telco Equipment sector. [Data from Aswath Damodaran of NYU's industry sector page.]

No one with market experience and common sense will bother looking at Damodaran's page, because a 50 P/E for any industry sector doesn't pass the sniff test. (If you tell me Swedes are 7 feet tall on average, I need neither a passport, nor a study to know you're wrong.) It is a statistical artifact of outliers: a few companies with 0.0001% margins, and astronomical P/E's.

Erring on industry valuations by a factor of 3 is pretty big deal, and destroys her thesis. (Getting lots of details right, but erring on the big picture is a common way to justify bubble prices.)

Chris Tarbert's piece, like Bryant's is well-written and informative. But whereas Shaughnessy's valuation conclusion is marred by madness, and Bryant's by a factual error, Tabert doesn't even attempt to value the company. He makes no attempt to link price to value; no attempt to justify price based on some set of expected future earnings, or cash flows.

In my report recommending shorting CLFD, I said:

"If their sales tripled overnight, and their operating margins went to 20%, then they'd be earning $1.70; at the current stock price, they still wouldn't be cheap!"

That's a sanity check that shows just how extreme CLFD's valuation is. Even if they do this stupendous thing, which they won't anytime soon, then they're still not cheap!

To repeat: "All intelligent investing is value investing - acquiring more than you are paying for. You must value the business in order to value the stock."

The reason CLFD bulls can't value it without making factual errors, or self-mockingly optimistic extrapolations, is because CLFD is absurdly valued. Slapping the industry norm P/E of 16 on CLFD's $0.50 trailing 12 month EPS implies a $8 target. Even a 24 P/E only gets you to $12, a 50% plunge from the current price.

So, Clearfield bulls, here's a challenge: Make a genuine attempt to justify the stock price without making factual errors, and without unjustified extrapolations that imply CLFD, a company with no patents, operating in a difficult industry, is going to grow faster than 99.99% of companies that have ever existed. Do the math. Value the business.

Disclosure: I am short CLFD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.